China Sends Shivers Down Global Economy’s Spine

By Inya Ivkovic, MA Published : January 25, 2010

— “The Financial World According to Inya” Column
by Inya Ivkovic, MA

I promised PROFIT CONFIDENTIAL readers to keep on monitoring China — and here it is again in the financial press, pulling a two-for-one with efforts to restrain its red-hot economy that are also threatening to cripple global recovery. In the last decade or so, China’s economy has grown to be a key player on the international trade stage, and any attempt to slow down its own growth, regardless of how small, is sending the rest of the world into a state of complete panic.

China is now focusing on restricting bank lending. As a result, commodity prices dropped last week, along with currencies of commodity-based economies, such as Canada and Australia. For sure, China could not have picked a worse time as the rest of the world is crawling its way back out of one of the most vicious recessions in a generation. Then again, it is hardly China’s fault for things being so topsy-turvy. Perhaps we needed a reality check to remind us that, even if the recession is behind us, we still have a long way to go before fully emerging out of it.

So what happened to China’s banks? The country’s banking regulator ordered some of its members to limit lending and it also disclosed preliminary plans on how to limit China’s credit growth rates. And the week before that, China’s central bank announced that the country’s banks will have to leave a larger chunk of customers’ deposits in reserves, which was the first such increase in the last year and a half.

In other words, China’s regulators and policymakers have realized that certain imbalances in the Chinese economy, while contributing to the economy’s rapid growth, could also be the source of serious problems in the long run. While this makes perfect sense from China’s point of view, there are legitimate fears that slowing down the Chinese economy would bring the U.S. recovery to a screeching halt. Why? All of this spells less demand for U.S. goods and services, less money coming in, and less fundamental strength, needed to go through the recovery.

I don’t know if you have noticed, but the timing of any event since the recession started could not have been worse. Indeed, China’s moves to rein in its economy last week came just as a number of key developed economies started painting a more bullish picture. For example, in the U.S., while December housing starts declined due to unseasonably cold weather, construction permits have increased by 11%. And, in the U.K., the unemployment rate dropped the fastest since 2007.

The world is trying to convince itself that the global recovery is sustainable, even if has to be done without consistent cooperation from commodity prices. But no one is foolish enough to believe that the global economy can recover without strong demand from the world’s fastest growing economy — from China.

A lot of hope is placed on China and it is a heavy burden to bear, even if the country has a population of 1.34 billion, as of July of last year. Yet, it appears there isn’t an economist out there who actually believes that China would risk a worldwide recovery by putting too much pressure on its “breaks.” I’m skeptical though. I understand China has to do something to control its economy. Whatever China does, and regardless of how miniscule it may seem at first, the rest of the world should brace itself for the unpleasant ripple effect, the only variable in this prospect being the degree of impact.